As tax reform negotiations pressed forward last year, there were high hopes that the dreaded individual alternative minimum tax (AMT) would be repealed. While the corporate AMT was abolished permanently, unfortunately, the individual AMT still exists under the Tax Cuts and Jobs Act (TCJA).
However, the AMT rules are now more taxpayer-friendly, and other changes to the tax code reduce the odds that you will owe the AMT while the changes are in effect (i.e. tax years 2018 through 2025). More than five million taxpayers owed the AMT according to the most recent IRS statistics. Under the new tax law, this number is expected to fall to somewhere between 200,000 (Tax Policy Center) and 500,000 (Joint Committee on Taxation).
This post provides an overview of:
• features of the AMT,
• how it is calculated,
• changes made by the TCJA, and
• risk factors that increase the chances of owing the AMT.
It concludes with an example of how to calculate the AMT under prior and TCJA law.
Introduction to the AMT
The AMT is a tax system wholly separate from the one used to calculate regular federal income tax liability. The main difference is that more—sometimes much more—of a taxpayer’s income is taxable under AMT rules. This is because the amount of AMT owed is determined using one’s “AMT income.”
This post provides an overview of:
• certain types of income that are tax-free under the regular tax system, and
• the amount of itemized deductions, in dollar terms, that are disallowed under AMT rules.
This more than offsets the fact that the maximum AMT rate is 28 percent in contrast with the 39.6 percent and 37 percent maximum rates under prior law and the TCJA, respectively. In addition, the minimum tax rate under AMT rules is 26 percent while the minimum rates under prior law and the TCJA are both 10 percent.
When calculating AMT income, taxpayers are allowed an AMT exemption which is deducted and phased out as AMT income surpasses the applicable threshold. As of 2018, however, the exemption amount increased from $84,500 to $109,400 (married filing jointly). The applicable threshold at which the exemption is phased out was also raised—from $160,900 in 2017 to $1 million for 2018-2025.
If your alternative minimum tax bill is greater than your regular tax bill, you owe the higher AMT amount. Technically, the AMT liability is the difference between the tax calculated under the AMT rules and the lower regular tax amount. For simplicity’s sake, however, we will refer to the entire amount calculated under the AMT rules as the AMT liability.
Past and present AMT risk factors
One of the biggest criticisms of the AMT has always been its complexity. So it is no surprise that numerous interacting factors make it difficult to say exactly who will be hit by the new AMT and who will not. Here are some common signs that you may owe the AMT under prior law and under the TCJA alternative minimum tax rules that apply for 2018-2025.
1. High income
No matter the source(s), high income can cause the benefit of the AMT exemption to be partly or completely phased out. This increases your AMT income, which in turn increases the odds of owing the AMT.
2. Large itemized SALT deductions
You could usually fully deduct state and local taxes (SALT) paid under the prior-law regular federal income tax rules (if itemizing), but they were disallowed under the AMT rules.
3. “Too many” personal and dependent exemptions
Under the AMT rules, these deductions are completely disallowed. However, personal and dependent exemption deductions are eliminated under the new law, so this will not be a risk factor again until 2026.
4. Significant miscellaneous itemized deductions
Under prior law, these could include investment expenses, fees for tax advice and preparation, and unreimbursed employee business expenses. You could write these off for regular tax purposes, but they were completely disallowed under the AMT rules.
5. Interest income from private activity bonds
This interest is tax-free for regular tax purposes but taxable under the AMT rules.
6. Deductions for home equity loan interest
Under prior law, you could deduct interest on up to $100,000 of home equity loan balances. But under the AMT rules, you could only deduct this interest to the extent you used the loan proceeds to acquire or improve your first or second residence.
Although, the TCJA suspended this deduction, home owners may still deduct interest on HELOCs as long as your original mortgage balance and the balance of your HELOC are under the mortgage interest deduction cap. If these balances exceed the cap (now $750,000), you may only deduct the share of interest payments equal to $750,000 divided by your initial mortgage and HELOC balances (i.e. if your original mortgage and HELOC balances were $1 million, you could deduct 75 percent of your interest payments).
7. Claiming the standard deduction
Standard deductions allowed under the regular tax rules are completely disallowed under the AMT rules. Because the TCJA nearly doubled the standard deduction, this risk has increased.
For 2018-2015, the new law almost doubles standard deduction amounts. So the TCJA increases this risk factor.
The following example illustrates how results may differ under the prior-law AMT rules and under the TCJA’s new rules for 2018-2025.
In 2017, a married couple filing jointly claimed itemized deductions totaling $50,000, half of which were for state and local income and property taxes. The couple’s income and deductions as well as the calculation of their regular tax and AMT liabilities are below:
In this case, the couple would have paid AMT in prior years because their exemption was partially phased out as they were above the income threshold. This resulted in their AMT liability being higher than their regular tax liability.
Under the TCJA rules, however, these issues no longer affect the couple. Their AMT income of nearly $300,000 is well below the new phase-out threshold of $1 million. Thus, they get the full benefit of the TCJA’s more generous exemption amount, which makes their AMT liability actually less than what they owe under the new tax code. As the taxpayer must pay the higher of the two amounts, they pay their regular tax liability of $55,059, or $6,712 less than they would have owed in years past.
Although the TCJA greatly reduces the odds that you will owe the AMT for 2018-2015, do not assume that you are now exempt. This is especially true if some of the AMT risk factors that remain under the new law apply to you. Not paying the AMT if you owe it will result in underpayment and therefore back taxes, interest, and possible penalties.
If you are one of the 200,000 taxpayers that still owes the alternative minimum tax under the new law, there is still reason to be optimistic. Although you may owe the AMT under the new rules, you likely owe less (potentially much less) than you did under the old rules. Talk with your tax professional to figure out if you are still hit by the new and improved (albeit temporary) AMT. Hopefully you can work together to reduce any liability you may owe.
This article is for informational purposes only. It should not be considered tax advice. Before making any tax decisions, work with a tax professional. For more detail, please see the full disclaimer.